December, December

“How did it get so late so soon?” – Theodor Seuss Geisel

It was a year of superlatives CBOE Volatility Index® (VIX® Index) products listed on Chicago Board Options Exchange, Incorporated (CBOE) and CBOE Futures Exchange, LLC (CFE®). For example at CFE, total VIX futures volume of 23.9 million contracts was up 68% over 2012 volume and was the fourth consecutive record volume year at the exchange.

For our final issue of “Futures in Focus,” we thought it would be worthwhile to reprise a favorite technique: reviewing the life of the most recent VIX futures contract that expired (December 2013) and extending the review to every December VIX futures contracts listed on CFE since their introduction in 2004.Sources: CFE, Differential Research, LLC
Looking at the trading history of the December VIX futures prices on a days to expiration basis, it would appear that VIX futures decline over time (as theoretically predicted), with several exceptions including one dramatic exception – 2008.Sources: CFE, Differential Research, LLC
While many believe the holiday contributes to lower implied volatility options and VIX futures contracts, (due to a shorted final 30-days in December), the VIX futures’ final settlement values were also contract lows. This seems to confirm volatility’s decay over time. For a group, the titles for the greatest intraday, daily settlement and final settlement values are all held by the December 2008 VIX future contract, while the December 2006 VIX futures contract claims the lowest values.

Sources: CFE, Differential Research, LLC
The magnitude of the growth in VIX futures trading is particularly dramatic when comparing successive VIX futures contracts expiring in December. Interestingly, the term for VIX futures has varied over time with the December 2008 future’s term approaching a full year, settling on the current approximate nine-month terms.VIX December 2004

Today, VIX futures contracts are added to maintain a continuous sequential time series. That, however, was not always the case and a few expiration gaps exist. Four VIX futures contract expirations that were never listed are the:

December 2004 VIX futures contract

April 2005 VIX futures contract

July 2005 VIX futures contract

September 2005 VIX futures contract

VIX December 2005

The first VIX futures contract expiring in December was the December 2005 VIX futures contract, which began trading on October 24, 2005 and expired 78 calendar days later on December 21, 2005. While several VIX futures contracts have had shorter lifespans, the December 2005 contract is the shortest term December VIX futures contract in our analysis.

Sources: CFE, Differential Research, LLC
The December 2005 VIX futures contract holds the record for having the lowest volume and open interest. That VIX futures contract traded only 3,629 adjusted contracts over its life with a maximum daily volume of 357 contracts. Open interest peaked at 1,713 contracts.VIX December 2006

The December 2005 and 2006 VIX future contracts are unique as they are the only two futures to expire prior to the change in the VIX futures’ contract multiplier from $100 to $1,000.

The December 2006 VIX futures contract had a 10-fold increase in volumes year-over-year, with 34,653 contracts traded, a maximum volume day of 3,746 contracts and open interest that peaked at 13,065 contracts.

Sources: CFE, Differential Research, LLC
The final settlement value for the December 2006 VIX futures contract was $100.50, adjusted for the contract multiplier value of $10.05, would be the low value for the 64 trading days and remains the lowest close for a December VIX futures contract. That settlement value is the second lowest VIX special opening quotation (SOQ) or final settlement value for any futures contract.VIX December 2007

Sources: CFE, Differential Research, LLC
The lowest final settlement value for VIX futures would take place two months later with the February 2007 VIX futures final settlement value of $9.95. The troubles brewing would slowly surface, however, with volatility generally rising for the balance of the year with the December VIX 2007 futures contract rising for much of its lifespan.VIX December 2008

Sources: CFE, Differential Research, LLC
The exceptional year!

Volatility exploded in 2008, ahead of the financial crisis, with the December 2008 VIX futures contract rising from a daily settlement low of $21.30 on May 2, 2008 to a daily settlement high of $66.23 on September 20, 2008. That high however is only the fourth highest settlement in VIX futures history, surpassed by the daily settlement values of the November 2008 VIX future. The November 2008 contract, which expired on November 17, 2008 at 67.95, also was the all-time high final settlement value .VIX December 2009

Sources: CFE, Differential Research, LLCVIX December 2010

Sources: CFE, Differential Research, LLCVIX December 2011

The December 2011 VIX futures contract is unique because it is the only expiring VIX futures contract to trade on the day it settled during morning extended trading hours from 7:00 a.m. to 8:30 a.m.(Chicago time), which was immediately before the final settlement for the contract was calculated.Sources: CFE, Differential Research, LLC
The December 2011 VIX futures contract was also a “round-trip,” with a low daily settlement value of $21.10 in July, a high of $36.70 in September and the second lowest settlement value, the final settlement, of $21.36 on December 21, 2011.VIX December 2012

Sources: CFE, Differential Research, LLC
The Federal Reserve’s policy of quantitative easing remained the focal point for volatility traders in 2012. Noticeably, the December VIX 2012 futures contract drifted higher into the June Federal Reserve meeting before declining for the balance of the year.VIX December 2013

Sources: CFE, Differential Research, LLC
Finally, the most recent VIX futures contract to expire was the December 2013 VIX future.

In many respects, 2013 the general decline in volatility was an extension of a trend that began in September 2011. As the Dec. 2011 chart shows, beginning in September 2011 there was a pronounced downward trend in the volatility of the Dec ember 2011 VIX futures as this contract neared expiration. This pattern of decreasing volatility continued in both the Dec. 2012 and Dec. 2013 futures contracts, mimicking the downward volatility movement trends of the Dec. 2005 and Dec. 2006 VIX futures contracts. The December 2013 VIX future’s daily settlement value peaked at $21.40 on June 26, 2013.

Finding comfort with the timeline for tapering clarified at the June Federal Reserve meeting, the December 2013 VIX futures contract drifted lower setting a contract settlement low of $13.60 on November 22, 2013. Reversing course, the future rose to expire at $15.84 on December 18, 2013, before the announcement (on the magnitude of initial tapering of quantitative easing) by the Federal Reserve that same afternoon.

Sources: CFE, Differential Research, LLC

The risk of loss in trading commodity futures and options is substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.

While many in the market are probably not even aware that the VIX Index has closed below $10.00, the measure of the market’s expectation for 30-day implied volatility for the underlying SPX Index has dipped below the $10.00 level on nine occasions, or 0.15% of the time, since January 1990 when VIX Index data is readily available.

data sources: CFE, Yahoo Finance and Differential Research LLC

Since 1990, these extreme levels for the “fear gauge” have occurred during two distinct low volatility periods.

data sources: CFE, Yahoo Finance and Differential Research LLC

The first period from December 1993 to January 1994 included 5 trading days where the VIX closed with a $9.00 handle including the index’s lowest reading of $9.31.

data sources: CFE, Yahoo Finance and Differential Research LLC

The second and more recent period includes 4 VIX closes below $10.00 between November 2006 and January 2007. The last single-digit reading of $9.89 occurred on January 24, 2007 just weeks before the first tremors of the 2007 – 2008 “financial crisis”.

data sources: CFE, Yahoo Finance and Differential Research LLC

Notably, both periods of single-digit VIX closes seem to have two characteristics in common, characteristics which arguable are in place today.

The first has to do with the calendar. Both periods of single-digit VIX closes took place over the November – January period or roughly over the winter holidays. While we look at the past twenty trading days to calculate realized volatility for what is approximately a monthly period, we look at 30 calendar days forward to calculate a month’s worth of implied volatility. The winter holiday period includes four extra-holidays, three of which occur within a thirty day period. The exchanges also close early the day after Thanksgiving and on Christmas Eve.

The second common factor is very low SPX 20-day Realized Volatility readings. In 1993 realized SPX volatility hit a low of 4.97% on December 23rd having spent much of the year in single-digits. Likewise SPX realized volatility remained below 10% for most of 2006 with the lowest readings near 6.00%

So where are we now?

data sources: CFE, Yahoo Finance and Differential Research LLC

Well we are heading into the holidays.

Thanksgiving Friday November 29 2013 – early close

Thanksgiving Day November 28, 2013 – exchange holiday

Christmas Eve December 24, 2013 – early close

Christmas Day December 25, 2013 – exchange holiday

New Year’s Day January 1, 2014 – exchange holiday

Martin Luther King’s Day January 20, 2014 – exchange holiday

Likewise SPX 20-day realized volatility has remained below 10% for much of the year with readings in the 6% range as recently as August.

If we are going record a single-digit VIX close it will require the SPX to close virtually unchanged (or slightly positive) several days in a row but could occur between Thanksgiving and Christmas.

Finally, I will be teaching a two-day course “Trading Volatility” in London December 5th and 6th and have limited availability to meet in London on December 4th. Let me know if you would like to meet me in London. Click the link for details.

data sources: CFE, Yahoo Finance and Differential Research LLC

The risk of loss in trading commodity futures and options is substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.